SANCTIONS ON RUSSIA—WHERE ARE INVESTORS MOST AFFECTED?

In Response to the military invasion of neighboring Ukraine, Russia has been sanctioned by numerous countries in an effort to force economic pain on the invaders.  As an economic weapon in the face of military action sanctioning is not new—it dates back to 432 BC in Greece.  It typically arises when a trading partner of one country sanctions individuals and/or the aggregate economy of another country owing to the second country’s political belligerence on another country.  This is done in an effort to inhibit the aggression of the belligerent without taking any direct military action.  In most cases sanctions will cause some form of economic hardship on the belligerent’s population, but at the same time, they can impact investors of the sanctioning country who have a vested interest in the country being sanctioned.  That being said, where are foreign investors most likely to be affected by the sanctions from the current war in the Ukraine? 

Oil:  Russia’s main source of foreign exchange comes from exporting crude oil.  By boycotting Russian crude, the price of crude oil has skyrocketed to $100 or more.  This restricts Russia’s foreign exchange reserves, and inhibits Russia’s ability to pay for imported goods.  Coupled with the decline in the value of the Russian ruble, this can cause a major hardship to Russian consumers trying to buy merchandise made in other countries.  Major western oil companies have discontinued projects with Russian oil partners, walking away from the investments already sunk in.  The impact this could have on the business of big oil should be negligible, however, since the current price of crude is so high, it could provide an adequate offset.  Further, the price of oil will likely settle back into an equilibrium once the non-Russian supply ramps up. 

Wheat:  Russia and the Ukraine together produce about 25% of the world’s wheat crop, much of which ends up being exported.  Sanctioning has caused some havoc in the wheat markets as most of the exported wheat is shipped out through the Black Sea ports in Crimea.  As of this writing, those ports are under the control of the Russian military, blocking any exporting of wheat by the Ukraine.  Russian wheat has not been specifically banned everywhere, but the financial sanctioning against Russia coupled with their retaliatory sanctions against western countries has resulted in buyers of wheat looking elsewhere for supplies.  The price of wheat has climbed dramatically and is roiling commodity markets at a time when planting for the summer season is set to begin. 

Ability to facilitate trade:  There are many sanctions in this category, not the least of which is banning Russian banks from using SWIFT—the Society for Worldwide Interbank Financial Telecommunications system.  Essentially the SWIFT system is an electronic messaging system that can transfer confidential banking information from bank to bank in a secure, coded, manner.  It crosses international boundaries, and enables individuals and businesses to make transactions in a simplified manner in spite of language barriers, etc.  The lack of trade from being banned from SWIFT impacts Russian consumers who are increasingly forced to buy domestic products from an economy that is becoming less and less capable of producing them.  Mastercard and Visa

Collecting debts and cashing assets:  The ruble has tanked in value, and the Russian government has declared that repayments of all foreign currency debt will be made in rubles instead of the corresponding foreign currency.  This should have a negative impact on bond holders who bought the securities in foreign currency, but will be paid back (if at all) in rubles.  Global Investment funds are busy dumping Russian stocks and bonds.  The plight of the ruble has reached about 50% from the 2014 Russian incursion into the Ukraine.  In spite of efforts by the Russian government to stem the outflow of capital, it is continuing to occur and the results are pounding the ruble. 

Conclusions:  At this stage of the war, the sanctioning has been largely of a financial nature.  The effect has been to restrict Russia’s ability to conduct foreign trade.  Unfortunately, the best time for investors to clear out of the mess has passed, and some financial pain will apply.  However, I don’t believe that this war will be over quickly, even if the Ukraine government is toppled and must rule in exile.  A protracted war such as the one the Russians carried on in Afghanistan in the 1980’s may follow leaving the financial situation in a never ceasing mess.  But a prolonged war of any sort will likely bring on more bombing, shelling, and wanton destruction by the Russian military, and more specific sanctioning by many of the world’s upper echelon economies.

Sources:         The Economic Weapon, The Economist, March 5, 2022.

                        How the SWIFT system works, Investopedia.com.  

                        edition.cnn.com, Russia Tries to Stop Western Companies Fleeing the Country, by Mark Thompson and Vasco Cotovio, 3/2/2022.